The course weblog for PA5113, State and Local Public Finance, at University of Minnesota

Thursday, March 19, 2009

Budget Cuts vs. Tax Increases

The grim economic outlook presents in front of state and local policy makers the formidable tasks to confront uncertainties and risks in the current recession. Minnesota is not an exception with the twin problems of a deficit and a recession: the state budget faces a 4.6 billion shortfall, while the unemployment rate hit seasonally adjusted 8.1 percent in February. The Minnesota Budget Project, an initiative of the Minnesota Council of Nonprofits, notes that a balanced solution to close the budget deficit, which provides for reasonable tax increases and spending cuts, is the most sensible course of action.

In last Wednesday discussion session, we talked about DFL's proposal of a broad array of tax changes, including imposing a fourth tier income tax rate on Minnesotans who earn more than $250,000 a year, and expanding the sales tax to clothing and legal and accounting services.

The revised budget plan, released by Gov. Tim Pawlenty on March 17th, however, still opposes raising state taxes. As what he has been doing in the past seven years as governor, Pawlenty prefers cuts, cuts, and more cuts. Now, he finds another backing--it is not what President Obama is doing. However, Minnesota cannot legally run a budget deficit and the federal government can.

Economists including Nobel Prize-winner Joseph Stiglitz and Office of Management and Budget director Peter Orszag have argued that spending cuts may be more harmful to a state’s economy during a recession than tax increases, especially when cuts are made to resources going to low-income families. By contrast, a well focused tax increase on high-income households is likely to have less impact on the state’s economy, since those households are likely to maintain their levels of consumption and simply save less. Besides, taking into account the fact that Minnesota’s tax system becomes significantly more regressive, indicated by the 2009 Minnesota Tax Incidence Study, certain change in income tax seems to be a possible attempt.

While Pawlenty continues to resist any tax increases, from 2002 to 2008, Minnesotans actually had a 21 percent increase in fees. Also in order to offset Pawlenty’s newly proposed cuts in aid, his Revenue Department assumes that local governments will raise property taxes, which will probably increase $626 million over the next three years. As commented by Sen. Tom Bakk, DFL-Cook, who chairs the Senate Tax Committee, “If it’s a property tax, if it’s a fee, if it’s a sales tax or an income tax, they’re all taxes and they come out of your pocket the same way.”

At his inauguration, President Obama said that the question people should ask “is not whether our government is too big or too small, but whether it works.” So, it makes little sense here in Minnesota the debate is about how best to shrink government. In such a gloomy economic downturn, the state leaders should be debating how the budget will restore economic security, opportunity and confidence for all Minnesota families, that is, it's for the leaders to figure out through whatever mix of revenue increases and program restructuring are best for the overall good. That is really what Minnesotans are asking for.